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March 3, 2013

Have 401(k)s Failed Investors?

Experts argue merits, areas for improvement to 401(k) plans

A panel of experts asked whether 401(k)s were a “failed experiment” at the 2013 NAPA/ASPPA 401(k) Summit in Las Vegas on Sunday. Despite a few disagreements on some of the particulars, the panel was largely in agreement: No, 401(k)s haven’t failed, but there’s always room for improvement.

Brian Graff (left), CEO and executive director of the American Society of Pension Professionals and Actuaries, led the panel in a discussion of what 401(k)s have done for participants and what could still be improved upon.

Kevin Crain, head of institutional retirement and benefit services for Merrill Lynch, told attendees that 401(k) plans started as a “great democracy” where the responsibility for decision making fell on individuals. Now, he said, we’ve moved to a “democratic paternalism” where plan sponsors are working to help people get more involved through built-in features like automatic enrollment, but as investors become more astute they can move away from the paternalistic aspects and take more control of their plans.

Karen Friedman, executive vice president of the Pension Rights Center, acknowledged that “there’s no question that everyone cares [about clients’ retirement] and wants people to save,” but noted 401(k)s had several weaknesses: they are designed as supplemental income, investment decisions and risk fall on individuals, and millions of people don’t have access.

Where people do have access, 401(k)s are useful, she said. People who can afford to make contributions can benefit —“if they can make the money last.” Payroll deductions make contributing easier for participants, and plans are easy to understand.

“We’d like to see money paid out over participants’ lifetimes and encourage annuitization,” she said. Unfortunately, many participants have to “overcome psychological barriers. When people see how much money they have, they don’t want to hand it over.”

Judy Miller, ASPPA chief of actuarial issues and director of retirement policy, agreed that automatic payroll deductions made saving easier for participants, and added that outcomes were even better when combined with automatic enrollment. She pointed to incentives like employer matches and tax deductions that help keep people in plans. Most of all, as a “free agent nation” where people change jobs frequently, 401(k)s’ portability allows participants to accumulate a good benefit over their lifetimes.

Graff raised fees and fee disclosures as a major issue in 401(k)s today. “There’s no appreciation among policymakers for how efficient the industry’s fee structure is,” he said. “We’re becoming exceedingly more efficient, but we’re not doing a good job talking about that success.”

Crain noted that larger plans can certainly take advantage of economies of scale for more participants, which keep fees low for both participants and plan sponsors. “There are two consumers” of 401(k) plans, he said: the participant and the plan sponsor. For participants, effective fee disclosure is “not there yet.” Fee disclosure for plan sponsors is “far clearer and they’ve been invoking their buying power quite effectively.”

Looking at some measures of 401(k) plans’ success, Miller pointed to participants’ increased likelihood of using a 401(k) plan over another retirement plan.

Investors are “14 times more likely to save if they have a plan at work than if they have to go out and get an IRA,” Miller said. “This is a broad-based benefit. We’ve managed to cover tens of millions of people.”

Balances, however, may not be the best measure of success. She warned that even among participants with modest incomes, account balances vary more with the time a participant has spent in a plan than with income. Furthermore, considering the number of times people change jobs, a participant may have more than one plan. Median balance figures often only reflect a participant’s current plan and current balance, Graff agreed.

“The 401(k) is just a structure,” Miller said. “The system has evolved due to the active marketplace. It’s not perfect, but I think it’s ludicrous to want to tear the system down.”

“We’re not trying to tear it down,” Friedman countered, “but there need to be improvements for when people don’t have access.” To benefit from a 401(k) plan, she said, “you have to participate and you have to know how much to contribute.”

Crain suggested one “easy way to engage people” was to tie the enrollment process to health care enrollment. “Everyone enrolls in health care,” he said, pointing to increased participation rates at Wal-Mart. When the retailer tied its health care and retirement plan benefits, participation rates increased from 20% to 70%, he said.

Another barrier for many investors, Friedman said, is that they are “more burdened than ever.” Contributing to a plan and saving for retirement are simply lower priority.

Furthermore, “financial literacy makes little difference to people’s outcomes,” she said, pointing to a 2010 survey from Brookings that found traditional sources of financial education have not generated strong evidence of positive or substantial improvements. “Even sophisticated people didn’t do well in the crash,” Friedman noted.

Leakage from loans on the plans represents a significant drag on investors’ balances, she said, especially among lower-income participants. Not only do they reduce their assets, they have to pay a penalty and taxes on the additional income. “If you do everything right, you still have to make the money last.”

Crain countered that “no matter what study you’re looking at, 80% of people who are contributing aren’t taking loans.” Furthermore, he said, the number of loans and hardship withdrawals participants are taking has been falling, and plan sponsors are allowing fewer loans.

The biggest problem, Miller said, is coverage. It’s “often called the small business problem,” she said, but about half of people who don’t have a plan work for a company with at least 100 workers. The problem is they work part time and are frequently ineligible to participate in retirement plans, she said.